Tax Tips for Maintaining your Freelance Consulting Business

Last week we shared, “10 Things to Know When Establishing your LLC.” In conjunction with the topic, we asked our Head of Accounting, Joe Davis to cover tax tips for maintaining your business, once it is launched. 

Below, we share more on ensuring your business is successful long after your first client. 

Q: Now that I have my own LLC, how do taxes work?

A: The IRS doesn’t recognize LLCs, so if you’re the sole owner, you’ll be taxed as a sole proprietor by default. This means your freelance profit will not only be taxed along with the rest of your income, it will also be subject to self-employment tax.

Q: What’s self-employment tax?

A: Self-employment tax is the business owner’s version of Social Security and Medicare tax, which together are known as FICA taxes. The total tax amount is 15.3% of compensation, and by law, employers and employees split this amount 50/50. Before you became your own boss, your employer withheld your 50% from each of your paychecks. But now you’re responsible for both sides of the equation, and we call that self-employment tax. The way to lower this tax is to elect S-Corp status, where the dividend part of your income is not subject to self-employment tax. If you’d like, Mylance CPAs can help you!

Q: Is self-employment tax an extra tax I have to pay now?

A: Unfortunately yes, you will owe self-employment tax on top of the calculated rate from your tax bracket. But the good news is that there are tons of ways to decrease your self-employment tax, through expense write-offs and other deductions.

Q: What kinds of expenses can I write off?

A: As a business owner, you’re taxed on your net profit, which means income minus expenses (also called write-offs or deductions). The IRS says you can write off anything that’s “ordinary and necessary” in your line of business. As a freelancer, this can mean lots of things; advertising, office supplies, software subscriptions, coffee with clients, professional development courses, bookkeeping services, legal fees, and the list goes on. Some expenses are only partially deductible though, so we recommend working with Mylance’s qualified bookkeepers to make sure you categorize your expenses correctly.

Q: Can I write off any of my personal expenses, like phone and internet?

A: Yes! This is one of the best parts of being a freelancer. Odds are that some portion of your personal costs pertain to your freelance business, and you can write off the business portion of those costs. This includes things like your home office, part of your phone and internet bills, car mileage that you drive for business, and health insurance premiums. At Mylance, we call this an “accountable plan” where you track your personal expenses related to the business, and the business reimburses you monthly for these costs. 

Q: How does all this work with an S-Corp?

A: If your LLC chooses to elect S-Corp status, a couple things will change. First, you’ll need to pay yourself an owner’s salary. This means you’ll need to set up an account with a payroll provider, and register for state payroll tax accounts. Second, your owner’s salary needs to be “reasonable” per the IRS rules. The meaning of this is subjective and based on each individual case, but it’s something our CPAs can help you analyze and pick a number you feel good about. Third, the income from your LLC is now split into two types: 1. Wages (from which you’ll get a W-2) and 2. Distributable profit (for which you’ll get a K-1). Your distributable profit is not subject to self-employment tax, so if the circumstances are right for you, you could potentially save thousands of dollars each year. There’s a lot to consider with S-Corp status though, so don’t rush into it, and talk to pro to help you make the best decision.

Q: I don’t have a 401(k) anymore. Can I contribute to a retirement account?

A: Absolutely, and now you have even more options as a freelancer. There are several options out there, but the two most popular options for business owners are a SEP IRA and Solo 401(k). The details of maintaining each plan are a little different, but generally you can contribute around 20% of your freelance profit, up to $58,000/year. Whatever you contribute is usually a direct deduction that decreases your taxable income, and you can still contribute to your Traditional or Roth IRA on top of that. There’s no one-size-fits-all here, so make sure you talk to someone who can help you pick the right kind of account.

Q: What are quarterly estimated taxes?

A: Think of these as paycheck withholdings for freelancers. Your old boss used to do this for you, but without that withholding mechanism, you’re responsible for paying in your taxes four times each year - April 15th, June 15th, September 15th, and January 15th. The goal here is to estimate how much taxable income and tax you’ll have for the entire year, then calculate the associated tax and make payments. Your requirement to pay is based on the amount of tax you paid last year, and if you don’t pay on time, you’ll owe penalties when you file your tax returns. With all the write-offs, deductions, and caveats in the tax code for freelancers, this calculation can get pretty complicated. If you don’t want to risk paying too much or too little in taxes, we’ve built a quarterly estimated taxes process that handles it for you.

Q: What’s the best way to keep track of all this stuff?

A: The best way to stay ahead and optimize your tax bill is to have a bookkeeping process for your business. All your expenses should be categorized, and we recommend keeping pictures of receipts whenever possible. Everything that runs through your books will directly affect your taxes, so a clean set of books will help you stay informed and avoid surprises. Our bookkeeping services are built by experienced accountants and tailored to freelancers’ specific needs, which enables you to spend more of your time doing what you do best, while someone else handles the paperwork.

Q: Do I have to use my home address on the registration forms?

A: Typically it’s not a problem to use a P.O. Box for your LLC’s mailing address, but the vast majority of states also require registered LLCs to provide a physical address for the business. As a freelancer, this means your home address is the default location, and will be listed publicly with the Secretary of State’s business records. If you have privacy concerns, there are virtual mailbox services that can provide your business with its own physical address for a fee.